Government Farm Programs, Less is Better

Farmers and consumers would be better off if all farm programs disappeared. While farm groups and farm district elected officials try to convince us farm subsidies are protecting us from food shortages, they couldn’t be more wrong.  Somehow, about 75% of the food products in a U.S. grocery store miraculously make it to market without any government help.

Implemented in the 1930’s during the Dust Bowl and Depression, farm programs were supposed to keep farms numbers up. They haven’t done very well in that respect.

Not to blame farm programs for everything, other factors were more important. Farming is hard, gruesome work, especially the 1930-60’s style. As the rest of the US economy flourished, the draw of 40 hour weeks and vacations propelled a migration from farms that continues today.

Figure 1; US Farm Numbers Source: USDA
Figure 1; US Farm Numbers
Source: USDA

Farm programs attempt to replace our wonderful market based system that continually adjusts prices so we never have a surplus or shortage of any food item. Farmer incomes are stabilized by high prices following a small crop and lower prices when harvests are large. Efficient operators are rewarded handsomely and inefficient ones are guided to change their management or find another career. The best thing about this market based pricing is that it is free.  One would think no rational country would ever replace our market system with the $multibillion conglomeration of farm programs we have. Obviously, we are not a rational country.

Government farm programs were originally designed to stabilize farm commodity prices. Unfortunately, price stabilization soon turned into price enhancement. In the 1950’s and 60’s, prices above the market clearing levels quickly built huge surpluses of wheat and corn. Figuring how to get rid of the stuff proved daunting until someone came up with the PL480 program. Using this, we gave surplus grain to countries needing food.

Unfortunately, local farmers weren’t able to compete with free grain from the US. In some cases, PL480 caused some countries’ local agriculture to shut down. Eventually, these countries told us what to do with our surplus grain.

Liberals that pass farm  bills are saying government is smarter than markets and can do a better job setting  prices. They are always wrong. When they raise prices over the market clearing level, we get surpluses that drive prices lower than where they were before the government intervention. Farmers and their legislators have gotten more sophisticated with their price enhancement, yet they keep getting the same results. You’d think after 80 years we’d learn.

Types of subsidies

This article on farm programs is not an encyclopedia of all the nuances of every commodity covered by government fiat. US sugar producers are perhaps the most interesting starting point. They are masters  in manipulating government to protect their high prices. Too bad their success cost their industry a fortune in lost sales and changed the nation’s eating habits.

Most US sugar comes from sugar beets grown in northern Minnesota and adjoining states. Sugar beet growing costs can’t compete with sugar cane grown in warmer climates. This didn’t deter US sugar producers. Using a combination of quotas and government protection against imports, US sugar producers ratcheted prices to over three times the world sugar price.

Rather than pay these outlandish prices, consumers switched to artificial sweeteners and sweeteners made from corn. While the market for sweeteners in the US more than doubled, the US sugar industry saw a 40% decline in per capita consumption from the mid 1970s to the late 1980s and a stagnant market since then.

Figure 2; Per Capita Sugar and Other Sweetener Consumption
Figure 2; Per Capita Sugar and Other Sweetener Consumption

Quotas are the most destructive type of farm program. They are a government blessed cartel. Canada has provided quotas for dairy producers since the early 1970’s and Europe enacted them  for dairy in 1984. The European Union is phasing them out in 2015.

Since quota implementation, Canada’s per capita milk consumption (which includes all dairy products) dropped by 20% while the US’s increased 10%.  Canada’s population increases barely manage to make up for the per capita consumption drop  while the US market increased almost 70% since 1970.

Figure 3; US and Canada Per Capita Dairy Consumption Sources: USDA and Canadian Dairy Commission
Figure 3; US and Canada Per Capita Dairy Consumption
Sources: USDA and Canadian Dairy Commission
Figure 4: US and Canada Milk Production Indexes. Source: USDA and Canadian Dairy Commission
Figure 4: US and Canada Milk Production. Sources USDA and Canadian Dairy Commission.

While quotas kept US farm sugar prices and Canadian milk prices high, they literally come with a price. Quotas take on a value of their own. Sugar producers have to own stock in their processing cooperative to grow sugar beets. In 2012, the annual ownership costs were over $328 per acre, their most expensive single input. Buying quota in Canada for one cow’s production costs $25,000. The annual loan payments on the $25,000 of quota paid over 25 years work out to be almost equal to the difference in milk price between the US and Canada.

US dairy industry, bust to boom

Thanks to President Jimmy Carter’s 1976 to 1980 presidency, economists were blessed with real world verification of equilibrium price theory.  Carter continually raised the government’s support price for milk (the price where government would buy surplus milk) above the market clearing price. By the end of his presidency, the US government literally owned mountains of cheese and milk powder that the market didn’t want.

in 1986, President Ronald Reagan  finally got rid of the surplus by scheduling drops in the government support price from $13.10 to $10.10 in 1990, where it remained for almost 25 years. Getting the government out of the milk business was a huge opportunity. Figure 4 illustrates the dramatic increase in dairy production and consumption in what many considered a mature market.

These demand increases are important since when production of a commodity is stable, the average price paid over time equals the average producer’s cost of production. When demand drops, the price drops below the average producer’s cost of production to lower supply. In the case of dairy since 1986, annual production increased over 40 percent. To get this extra production, market prices are significantly above the average cost of production.

While not all producers made money during this boom, the more efficient ones were able to take advantage of new technology and essentially rebuilt the industry with at least 75 percent of today’s milk produced in facilities built since 1990. While US dairy producers were threatened with imports in the early 1980’s, today they are able to compete for the growing Asian dairy markets with all competitors.

Unfortunately, this success story doesn’t have a happy ending.  The 2014 Farm Bill’s dairy section authorizes price insurance for milk producers. The insurance is heavily subsidized by taxpayers.

Before this insurance was available, producers planning an expansion calculated their ability to survive low price cycles. Now, they will ignore this frugality as they tailor their expansions to the Farm Bill insurance and not market demands.

The price insurance will lead to unwarranted expansions causing surplus production causing lower prices. The lower prices will trigger government insurance payments to producers. Since insured producers won’t notice the effects of lower prices, the insurance payouts and opportunity to buy more insurance will spur even more unneeded expansions and milk production.

Sadly, the golden era dairy producers enjoyed during their years of minimal government involvement are ending. Even sadder, dairy producers brought this on themselves through their National Milk Producer’s Federation.

US commodity farm programs

While some US commodities rely on quotas, most farm program covered crops (wheat, corn, soybeans and others) use a combination of Price Loss Coverage and subsidized crop insurance. Using a formula, USDA sets reference prices several months ahead of planting. If the annual average price the following crop year  is low, enrolled producers receive a check for the difference between the reference price and the actual annual average price. There is a $125,000 payment limitation per person. Recipients must have annual net incomes below $900,000 to receive protection. Some lawyers specialize in structuring farms between different family members so their clients can collect a number of maximum payouts.

Farmers buy crop insurance that is heavily subsidized by the government. This is an incentive for them to plant crops on “fragile” land. Fragile land is typically prone to erosion and doesn’t have high yield potential. In a typical growing season, they will collect on their crop insurance because of poor yields and in a really good crop year, they make money on high yields.

If you are paying attention, you start to catch on to how counter productive these programs are. Regardless of supply and demand conditions, farmers will plant fence-row to fence-row to take advantage of the subsidized crop insurance and price guarantees. Because they planted so much, there is more supply, which pushes crop prices below the Price Loss Coverage levels. Like with the dairy example above, taxpayers are stuck making up the difference for the low prices.

The federal government requirement that gasoline contain at least 10 percent ethanol (produced from corn) is another market distortion. Although not part of the farm bill, the ethanol requirement is just another example of a government drain on the economy. While consumers pay more for ethanol-supplemented gasoline, studies consistently find it takes much more energy to produce a gallon of ethanol than what it provides.

The ethanol industry is dependent on government. Without the government edict on including ethanol in gasoline, there is no ethanol industry.

Logically, government would remove the ethanol requirement and instead add more to the gasoline tax to pay for much needed road repair. Unfortunately, nothing about farm programs is logical.

During the George W. Bush administration, US farm programs had a negative impact on farmers in developing nations. Because of the Price Loss Coverage (previously called Target Price) program, US producers received a price for their grain far above the market-clearing price.  There were no payment or income limitations. This incentive prompted US farmers to overproduce covered grains. This overproduction dropped the market price for grain on world markets below the cost where small Third World farmers can grow it. US farmers didn’t care because they got a government check covering the difference between the market price and the Target Price. However, the low market prices stirred up even more anger against the United States in countries like Somalia and Yemen that are already terrorism powder kegs.

Why do we have these pink elephants?

We have these programs because farmers want them. Congressional agriculture committees are stacked with farm district legislators who aim to bring home the bacon. Checks and balances don’t generally exist as Congress usually passes what ever comes out of committees. Presidents rarely make changes in farm bills. Obviously, Tea Party Republican legislators representing farmers have a completely different definition of government waste on programs applying to white farmers versus poor black people

Understanding why farmers continually push for these programs requires a little economics understanding. Reviewing the dairy economics, for any commodity, when

Figure 5.Northeast WI Dairy Producer Net Incomes, 2001. Source Lakeshore and Fox Valley Farm Management Cooperatives
Figure 5.Northeast WI Dairy Producer Net Incomes, 2001. Source Lakeshore and Fox Valley Farm Management Cooperatives

demand is stable, about half the producers are not covering all their production costs, a competitive rate of return on their equity and labor. A breakdown by income levels resembles a bell curve like those in Figure 5 using actual farm incomes. Those on the left side of the graph are financially hurting. Rather than admit they aren’t good managers, it is easier to expect government to solve their problems with higher prices.

The other reason many farmers push for these programs is they don’t trust markets. Believing large food processing companies have market power and can lower prices on a whim, these farmers think they need government price protection.

Unfortunately for this line of thinking, the only substantiated case of food price manipulation involved DFA, a dairy farmer owned cooperative, that attempted to upwardly manipulate milk futures markets. The cooperative and executives paid over $12 million in fines to settle the case.

In reality, markets protect farmers. If in the unlikely event a consortium of buyers worked together to lower prices below the market clearing level, they would create a shortage that later causes prices to rise dramatically.

Summing-up

Answering the concern that government farm subsidies protect us from famine, we should prefer having our food produced by business people capable of farming through all sorts of extreme weather and market fluctuations than farmers whose management revolves around maximizing returns from government programs.

Both Democratic President Barack Obama and Republican House Budget Chairman Paul Ryan called for cuts in the 2014 Farm Bill. What they wound up with is a bill that provides outlandishly high price protections for some crops and a dairy provision offering heavily subsidized price insurance. The 2014 Farm Bill  is a blatant  example of government waste with taxpayer subsidized crop insurance driving increases in production that activate taxpayer financed price protection provisions . It represents a 49 percent increase from the last (2008) bill. After subtracting out food stamp and nutrition programs,  the current ten-year farm bill costs over a $200 billion, or $20 billion per year. Land rents and prices will increase in response to the high Price Loss Coverage, transferring much of the gains to non-farmers.

The truth of the matter is, the US does not need farm bills. They are a blatant example of over reaching government in an area (price discovery) where free markets do a better job. While some Republicans call for eliminating government (and then in the shadows, work for a bigger farm bill), the emphasis on this website is for a smarter government that only gets involved in markets when necessary.

This column doesn’t have a happy ending. Getting rid of farm programs requires successive President Bill Clinton style leadership that we simply don’t have.  While we need to end deficits and money is lacking for critical enhancements to our schools and colleges, farm programs continue as an example of government waste and ineptitude.

 


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